In the mainstream economic literature, public education expenditures have been recognized as a key aspect of fiscal outlays in most developing countries of the world. The reasons put forward in defense of government involvement in education financing are not far-fetched. Empirically, education and human capital have been found to have a positive and significant effect on economic growth (World Bank, 1980; Barro, 1998; Barro & Sala-i- Martin, 1995), reduce fertility rates (Moock & Jamison, 1988), improve health and enhance social and political participation (Hill & King, 1991).

According to Sen (1999), education has both intrinsic and instrumental value. It is desirable not only for the individual but also for the society as a whole. Education as private good benefits directly those who receive it, which in turn affects the individual’s future income stream. At the aggregate level, a better educated workforce is thought to increase the stock of human capital in the economy and increase its productivity. Considering the externalities prevalent in education, it is widely accepted that the state has a key role to play in ensuring equitable distribution of educational opportunities to the entire population. This is particularly crucial in developing countries such as Ethiopia that suffer from high levels of poverty, inequality and market imperfections. Public intervention in education can lead to improvement in the future stream of individuals, enabling equitable distribution of wealth and help reduce poverty (Mukherjee, 2007).

Education being an important component of human capital has always attracted the attention from economists, researchers and policy makers. Governments are trying to improve Human capital by pumping more investments in education. Education increases an individual’s earning potential, but also produces a ‘ripple effect” throughout the economy by way of series of positive externalities (Michaelowa, 2000). Educational expenditure constitutes a significant share in government’s budgetary expenditures. Individual families also set aside a good share of their private disposable income to school their children, foregoing the productive contribution the children would have made to family income had they not attended school. This is mainly